Cyprus Talks Went to Wire With Rancor, M&M’s

Top European officials hashed out an accord in Monday’s early hours that probably saved Cyprus from becoming the first country to crash out of the euro, but at the price of deepening the political mistrust between the strong economies of Europe’s north and the weaklings of the south.

The often-chaotic negotiations that led to the agreement have shattered the calm in the euro zone. The bitterness over the Cyprus mess—deeper initially than at low points in Greece’s extended financial turmoil—could leave lasting damage and hamper future attempts to fix the bloc’s flaws. Germany, the euro zone’s biggest economy, prevailed in the talks, but at the price of growing resentment over what some Europeans saw as its bullying of a tiny nation.

Cyprus secured a bailout from its international creditors early Monday in a deal which, according to European officials, closes Cyprus’s second-largest bank, Cyprus Popular Bank, and imposes steep losses on depositors with more than approximately $130,000. Gabriele Steinhauser reports. Photo: Reuters

The accord will see big depositors losing large sums following the radical downsizing of the country’s largest bank and the shuttering of its second-largest. As part of the so-called bail-in of the two largest banks, large depositors in both will suffer big losses.

As Cypriots waited nervously on Monday for banks to reopen after a 10-day closure, Dutch Finance Minister Jeroen Dijsselbloem hinted that big bank depositors and senior creditors may be expected to contribute to future euro-zone bailout packages.

«Now we’re going down the bail-in track and I’m pretty confident that the markets will see this as a sensible, very concentrated and direct approach,» he told Reuters and the Financial Times. But later, in a tweet from his account, he appeared to backtrack: «Cyprus [is a] specific case. Programmes tailor-made to situation, no models or templates used.»

Matters were brought to a head by the European Central Bank, which threatened to cut off liquidity to Cypriot banks—condemning them to instant bankruptcy—if no deal was reached by Monday.

On Sunday, officials said negotiations were close to breaking down on several occasions. «Nobody wanted to take the decision that could have led to the first exit of a euro member,» said one official following the negotiations. «But it could have been the consequence.»

Monday’s agreement followed a 10-day psychological drama. Cyprus’s president struck an initial deal that would have seen the country raise its share of the bailout funds by requiring all account-holders in Cypriot banks to pay a tax on their deposits, only to see the plan struck down by parliament. Cyprus went hat-in-hand to Moscow for help, to no avail. At several points, communications broke down between Nicosia and other euro-zone governments.

In the end, the accord ended up looking like a radical plan floated by Germany and the International Monetary Fund to close the country’s two biggest banks—a plan that had been rejected by Cypriot President Nicos Anastasiades 10 days earlier.

Monday’s deal would see depositors with less than €100,000 ($130,000) in their accounts keep all of their money. Bigger depositors in the two largest banks are set to pay a sharply higher price, one that increased over the previous 10 days. Large depositors at Cyprus Popular Bank, the second-largest bank, will have their deposits converted into shares in a «bad bank» to contain poor-quality assets, and will likely be repaid only a small fraction of their deposits over time.

The earlier accord was quickly perceived as a mistake by German Chancellor Angela Merkel and others. On March 18, she voiced her irritation to leaders of her conservative Christian Democratic Union party. Euro-zone finance ministers should never have agreed to a levy on small savers, she said, according to people familiar with the CDU meeting. Ms. Merkel wasn’t happy with her finance minister Wolfgang Schäuble for going along with a levy on all deposits, these people say.

After Cyprus’s Parliament rejected the deal on March 19, as President Anastasiades had warned it would, officials from Germany and other creditor countries grew more irritated by the day as they waited to hear Cyprus’s promised «Plan B.»

Cyprus’s Finance Minister Michael Sarris, in Moscow for days, wasn’t returning calls from his euro-zone peers. His officials weren’t talking to its negotiating counterparts from the troika of the IMF, European Central Bank and European Commission.

The troika experts spent up to 16 hours a day holed up in the glass-front Central Bank building in Nicosia, which was empty amid the imposed bank holiday that kept employees away from their desks. Seldom did Cypriot officials show up to join them, according to European officials.

Struggling to collect information from the ground, Brussels-based officials relied on media reports to get a sense of what the Cypriot government was planning. «It’s difficult to disentangle from the Cypriots who is proposing what. They make the Greeks, at the extreme worst of our negotiations with them, look like Swiss efficient professionals. I have never, ever witnessed anything like this. It’s a disaster,» said a senior euro-zone official. Another senior European Union official called the situation «terrifying.»

A Cypriot official countered that Nicosia had advanced several proposals in a bid to contain the fallout on the eonomy and society. «The troika were the ones coming with more and more demands,» this official said. «They had a clear mandate not to move from their positions. The issue was political, beyond economic rationale.»

The fight over the future of Bank of Cyprus, the country’s largest lender, became heated by Thursday. Officials in Brussels and in Cyprus noted the decision was personal for many Cypriot parliamentarians, many of whom keep their life savings there.

Mr. Anastasiades tried to sway Ms. Merkel, asking her by phone for a more lenient deal, according to people familiar with the call. The chancellor told him bluntly that she wouldn’t haggle over the specifics of the deal and that Cyprus needed to talk to the troika.

On Friday morning, Ms. Merkel’s patience was running out. She angrily briefed lawmakers from her ruling center-right coalition and told them Cyprus was trying to face Europe down, according to people present. Cypriot leaders haven’t understood yet that their «business model» of outsized offshore banking has failed, she said. Europe had to stick to its principles, she added: Aid is only for countries that were prepared to reform, she said, according to these people.

Ms. Merkel told the lawmakers that Germany wouldn’t accept any Cypriot Plan B that involved a raiding the island’s pension funds. Given the popular backlash against the bank levy, Germany didn’t think a proposal to grab pensions would go down well.

Germany’s leaders had believed all along that the only realistic solution for Cyprus was to wind down one or both of its big banks and bail in large depositors. Ms. Merkel and Mr. Schäuble told other German officials during the week that events would leave Cyprus with no choice but to accept a bail-in.

Ms. Merkel told her advisers and lawmakers she didn’t want to see Cyprus leave the euro zone. The knock-on consequences for Greece and other crisis-hit euro members would have been too unpredictable for her, said people familiar with her thinking.

But the chancellor and her finance minister prepared to let Cyprus fail if it wouldn’t agree to terms, German officials say. «There can be no question of aid for countries that want to carry on merrily as before, and the Bundestag would never agree to that,» said a senior German official.

With this as the backdrop, the mood was running high Sunday in Brussels as key officials—including IMF chief Christine Lagarde, ECB head Mario Draghi, EU President Herman Van Rompuy and other EU leaders—met Mr. Anastasiades over a lunch of lamb and stuffed baby potatoes.

Mr. Anastasiades, whom several officials described as emotional and erratic, complained that his country was being treated more harshly than any of the euro zone’s other bailout victims. He backtracked on an earlier agreement to wind down Cyprus Popular Bank and got into a direct confrontation with Mr. Draghi over the ECB’s treatment of his country’s banks.

At one point, he threatened to resign—triggering accusations from his European colleagues that he was more concerned with his political image than the future of his country in the euro zone.

«He was so out of whack,» said one official. «But the good thing with the fact that he was so out of whack was that it forced the troika to converge.»

According to a senior Cypriot official, Mr. Anastasiades was appalled by the way he was being treated and spoken to at the lunch. When he threatened to resign, Mr. Dijsselbloem told him he didn’t care about the president’s political future, only the future of the euro zone.

The lunch ended two or three hours later «and not in a good mood,» said a second official.

With the troika now united in a common front, the technical experts from all three institutions went to work in the European Council’s headquarters in Brussels on a new proposal for Cyprus: Wind down Cyprus Popular Bank and fold its good assets into Bank of Cyprus. That would allow the country’s largest bank to stay alive, though its large depositors will also face steep losses.

Most euro-zone finance ministers summoned to the building to sign off on the deal were forced to wait, many growing bored in their national delegation rooms on the seventh floor of headquarters.

Germany’s Mr. Schäuble grew particularly irascible with the delays, officials said. At one point Ms. Lagarde, a friend, went to calm him down, these people said. «And she was very good at that,» one of them said.

Ms. Lagarde tried to raise spirits, too, in Mr. Van Rompuy’s fifth-floor suite, where top EU officials were meeting with Mr. Anastasiades. The IMF chief handed out M&M candies, as officials say she often does at late-night European negotiations.

The German minister wasn’t the only one wondering what was taking so long. When Mr. Dijsselbloem informed the group that the Eurogroup meeting might have to wait until 7 a.m. on Monday, Austria’s finance minister Maria Fekter erupted in fury, a senior European official present says.

Meanwhile, as EU leaders tried to calm Mr. Anastasiades and convince him to accept the need for radical surgery to Cypriot banks, his finance minister, Mr. Sarris, was negotiating an eight-point action list in another room with EU Commissioner Olli Rehn, ECB executive-board member Jörg Asmussen and Austrian official Thomas Wieser, who chairs the euro zone’s regular consultations among finance officials, according to people familiar with the meeting.

The «annex» that the four men drafted specified that Cyprus Popular Bank would be broken up immediately. Its better assets, insured deposits and central-bank liquidity would be folded into the larger Bank of Cyprus. Its soured loans and uninsured deposits would be put in a «bad bank,» which would be wound down.

While the lunch brought the creditors closer together, it didn’t help getting Mr. Anastasiades on their side.

«There was some real worry that this wasn’t going to fly,» said one European official.

As the evening dragged on, Mr. Schäuble and French Finance Minister Pierre Moscovici tried to nudge the talks with Mr. Anastasiades, from which they were excluded, toward a conclusion. They consulted their respective leaders, Ms. Merkel in Berlin and President François Hollande in Paris, by phone. Then they conveyed a message to the Cypriot leader.

The Franco-German message: Mr. Anastasiades should give up hope that a summit of euro-zone leaders would lead to an easier deal. Even if a summit were called, the deal facing Cyprus would be the same one as now.

Shortly before midnight, the Cypriot president came back with a new proposal, which officials said once again backtracked on the closure of Cyprus Popular. At that point, the EU leaders calmly told Mr. Anastasiades «to pack up and leave» if he wasn’t ready to cooperate, one official present at the meeting said.

It was at that moment that the president gave the sign-off on the broad deal and euro-zone finance ministers finally got to spring into action. They drafted a statement summarizing the deal, but didn’t alter the details outlined in the annex.

«The reality is that all decisions had been taken before,» one official said. The upshot for Cyprus was an agreement that was more costly than the one its parliamentarians rejected last week.

«There is no doubt in the government that the first deal was far better,» said a senior Cypriot official. «We bluffed and we lost. The whole thing was a fiasco.»